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Aug 31, 2017 (LBO) – Moody’s Investors Service says that the outlook for Sri Lanka’s banking system is negative, with both asset quality and profitability under pressure with macroeconomic risks.

Srikanth Vadlamani, a Moody’s Vice President and Senior Credit Officer says the economy will only see a modest growth rebound as the government’s fiscal constraints continue to limit public investment and private spending, despite stronger goods and services exports.

“Credit growth was very high over the last two years, with the credit multiplier (credit growth/GDP growth) shooting up to an average of 2x over 2015 and 2016, up from 1x in 2014,” says Vadlamani.

“As the loans made over this period start seasoning, asset quality will deteriorate. In addition, rising interest rates add to repayment burdens. However, increased loan loss reserves will provide some comfort,”

Moody’s said at the same time, capital will remain stable as the banks are raising capital and reducing dividends to comply with Basel III requirements, though execution and market risks could derail fund-raising efforts.

“Under our baseline scenario analysis, capital, as defined by tangible common equity to risk weighted assets, willdecrease to 7.6% at end-2018 from 7.8% at end-2016, without any additional equity raising,” Moody’s said.

“The funding profiles of the banks are set to improve after weakening in recent quarters, as loan growth slows down.”

Moody’s further said Sri Lankan banks hold sizeable liquid assets to cover their liquidity needs and movements in deposits.